Revision Notes

Income elaticity of demand

The Income Elasticity of Demand (YED) measures the rate of response of quantity demand due to a raise (or lowering) in a consumers income.

Income elasticity of demand=

% change in quantity demanded

% Change in Income

Normal goods: an increase in income leads to an increase in consumption, demand shifts to the right. Thus YED is positive for normal goods.

Inferior goods: Income elasticity is actually negative for inferior goods, the demand curve shifts left as income rises. As income rises, the proportion spent on cheap goods will reduce as now they can afford to buy more expensive goods. For example demand for cheap/generic electronic goods will fall as people income rises and they will switch to expensive branded electronic goods.

Basic or necessity goods have a low income elasticity i.e., 0 < ? < 1. Quantity demanded will not increase much as income increases (income elasticity for food = 0.2)

Luxury goods have high income elasticity i.e. ? > 1. Quantity demanded rises faster than income. For restaurant meals income elasticity is higher than for food, because of the additional restaurant service.

In different types of economies, the demand for goods and services are determined by the income elasticity. As economies grow, firms will want to avoid producing inferior goods. The reason being as income increases more and more people will switch from inferior goods to superior goods.